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Category Archives: Institutions and regulation

This year’s Nobel Symposium has been on the topic of Growth and Development. Several of the presentations (available here) deal with the impact of institutions on economic growth and development. The contributions by Daron Acemoglu and Andrei Shleifer in particular do a great job in taking stock of what we know about the role institutions play in society and the economy. And the discussion is useful in understanding the methodological challenges in demonstrating the importance of institutions as well. Highly recommended.

Abstract: The increased use of early agreements in the EU co-decision procedure raises the concern that intra and inter-institutional political debate is sacrificed for the sake of efficiency. We investigate the effect of early agreements (trilogues) on the time it takes for legislation to be negotiated during the first reading of co-decision. We find that the first reading negotiations of trilogues on salient legislation take longer than first readings of similar files reconciled at second and third reading. First readings of early agreements also appear to last longer when considering all co-decision files submitted to the 5th and 6th European Parliaments, but the effect is masked by a general increase in first reading duration after 2004. We conclude that even if early agreements restrict access of certain actors to decision making, they allow for more time for substantive debate at the first reading stage than similar files reconciled later in the legislative process.

By the way, let me use the occasion to congratulate EIoP for being one of the very few free and rigorously peer-reviewed, SSCI-indexed, journals. All articles are available online without a subscription and without a registration. While many people talk against the gated and hugely expensive academic journals, very few authors actually support the free alternatives by submitting to and reviewing for them.

Francis Fukuyama reviewsWhy Nations Fail, the new book by Daron Acemoglu and James Robinson, at his blog. The review is fairly critical. Fukuyama agrees that institutions are of paramount importance for development (as you would expect given his own recent book) but is unsatisfied with the vague (or even missing) definitions of the two central concepts of the book – ‘inclusive institutions’ and ‘extractive institutions’. This conceptual stretching allows the labels to be applied quite arbitrarily to fit the argument of the book.

In substantive terms the critique boils down to the question whether democratic (inclusive) institutions are necessary for stable economic development. In Fukuyama’s view they are not (think contemporary China) and might even be counterproductive (following Huntington). In Acemoglu and Robinson’s view, democratic political institutions and inclusive economic institutions are indispensible for sustained long-term development. Fukuyama’s quibble with Why Nations Fail fits into a line of argumentation he is in the midst of constructing which can be summarized as ‘good governance is necessary for development but democracy is not necessary for good governance’. His latest project, for example, is to develop a new conceptualization and measurement of governance which moves away from the traditional indicators of (Western-style) rule of law and democratic accountability. Here is a characteristic quote from the project’s announcement:

One can think of many ways in which greater democratic participation actually weakens the quality of governance.

Acemoglu and Robinson respond to Fukuyama’s review at their own blog. But in my opinion Fukuyama’s general critique (and his smaller points about misinterpretations of historical episodes) remains. Irrespective of one’s normative convictions, one has to admit that economic development has been possible throughout history and space in the absence of inclusive, democratic institutions (unless one stretches the definition of democratic institutions to include 17-th century England or contemporary Singapore). Whether growth without political democratization is sustainable in the long term remains an open question (China).

Both Fukuyama and Acemoglu & Robinson focus on macro-level institutions but it is instructive to look at the meso- and micro-levels of institutions as well (taking the work on the management of common pool resources by Elinor Ostrom and others as a guide). In my reading, the message of this literature about inclusiveness, democracy and governance is the following: Successful management of common resources needs some form of participation and voice by the people within the community but also restricted access to the resource. Effective governance needs institutions that are inclusive for ‘insiders’ and exclusive for ‘outsiders’. For example, early community-based institutions for managing marine resources throughout the world provided for some influence by ordinary members of the community but at the same time they strictly defined who can and cannot fish and enforced these boundary rules. Of course, who is an outsider and who is insider is in itself a political question. And we don’t know whether these lessons from the micro-level generalize to society-wide institutions.

Finally, although I remain skeptical whether democratic (in the narrow sense) institutions are necessary (in the strong sense) for economic development, the recent experience of Central and Eastern Europe (CEE) suggest a strong link between the two. Even for those with only cursory knowledge of the region would be clear that the countries that installed the most open, democratic and inclusive political regimes are also the most economically successful ones. In the early phases of post-communist transitions after the fall of the Berlin Wall many advocated economic development before political liberalization. In line with Fukuyama’s reasoning, it was feared that democratization prior to, or together with, economic reforms would impede development and lead to the implosion of these countries. Fortunately for the region, these opinions did not prevail and most of the CEE states initiated political and economic reforms simultaneously (in some cases with the additional burden of nation-building). Looking back, we can ascertain that those states which experienced the earliest and most far-reaching political liberalization were also the ones to achieve the greatest economic development (Poland, the Czech Republic, one hesitates to add Hungary). Whether economic reforms led or followed political liberalization or whether they were all predetermined by pre-communism legacies, political culture, etc. might be still an unresolved issue. Nevertheless, at the very least we can say that in CEE the establishment of democratic political institutions did not halt economic development.

Here is a link to my interview for Gulan Magazine discussing how to establish good governance and the role of formal institutions.

“Even if institutions are working in Western Europe or in the US and they are imported to the developing countries, there is no guarantee that they would produce the same outcome because institutions are embedded (they function) in a certain environment and when they are transferred to other countries there is no guarantee that they would work. I have some experience observing from very close the institutional transfer recommended by the western advisers to the countries of Central and Eastern Europe – these countries were consolidating their democracies and when they were building their market economies – some of the imported institutions worked and some of the institutions that were suggested by western experts were actually counterproductive. Again, importing institutions can only do that much – it really depends on the local people to make them work. There are some institutions that obviously benefit the society in many different contexts no matter the country, developing or developed. For example stable civil service.”

This is what economist Paul Romer calls Myron’s Law (after Myron Scholes). It is a great aphorism as it illuminates a neglected source of institutional change – the opportunistic adaptation of the regulated actors to the rules which spurs transformations of the rules which leads to behavioral adaptation, ad infinitum. Usually, institutions are regarded as sticky, slow-moving and resilient to change. Which might be true for constitutions, but is easily disqualified when once looks beyond the fundamental ‘rules of the game’ into tax codes, the network of public organizations, the details of electoral systems and other lower-level institutions. Few seem to realize that these change all the time, and we have precious little theory to explain why. In fact, the degree of change is such that one wonders whether tax codes and the like qualify as institutions at all. In a way, they are like the proverbial river – always changing yet somehow remaining the same.